To be included in the S&P 500 index, a company needs to be based in the United States. Since it's a constituent of the S&P 500, many people think of Starbucks (SBUX -0.35%) as a U.S. company. Indeed, it's headquartered in Seattle. However, this coffee giant's business is increasingly focused on China.
As we'll see, Starbucks stock looks reasonably valued right now. But it would look darn cheap if China was living up to its full potential. And that's why a rebound for business in China could catalyze Starbucks stock.
The importance of China to Starbucks
Starbucks' fiscal year ends in October. During its fiscal 2022, the company opened 661 net new company-operated locations in China. For perspective, it only opened 1,120 net new company-operated stores globally. Therefore, 59% of all new company-operated Starbucks locations in fiscal 2022 were opened in China. Moreover, in the first quarter of its fiscal 2023, Starbucks opened 71 net new locations in China, which was 30% of Starbucks' new company-operated store openings.
With 6,090 locations in China at the end of Q1, almost 17% of all Starbucks locations worldwide -- including licensed stores -- are located in China. Therefore, this is a huge part of the business, and likely bigger than a lot of investors realize. Longer term, China figures to become even more important to Starbucks' financial results. Management intends to have around 9,000 Starbucks locations in China by the end of 2025. Suffice it to say, China is the focal point of the company's growth plans for the foreseeable future.
Therein lies the problem for Starbucks. China's government has been especially strict because of the COVID-19 pandemic, and this headwind is still blowing nearly three years later. To illustrate the headwind's magnitude, consider that Starbucks' Chinese operations generated nearly $2.9 billion of revenue during fiscal 2019, which ended in September 2019. It had 4,123 stores in China at the end of that fiscal year.
At the end of fiscal 2022, Starbucks had just over 6,000 locations in China. But it only generated $3 billion in full-year revenue. In other words, with nearly 2,000 extra locations, it's only generating about $100 million in incremental annual revenue -- far below what one would expect under normal circumstances.
I'm not saying that new Starbucks locations in China are performing poorly. Rather, sales across the entire base of stores have fallen dramatically during the pandemic era because of restrictions in that country. Therefore, the benefit of all of these new stores isn't manifested in its top-line results. But new stores do increase operating expenses and are consequently a drag on the bottom line.
The catalyst for Starbucks
Looking at Starbucks stock right now, I'd say the valuation looks fair: Not dirt cheap, but within reason. One metric to consider is the company's price-to-earnings (P/E) ratio, which is currently at 37. That's around what I'd call the high end of normal for this stock over the past eight years, as the chart below shows.
SBUX PE Ratio data by YCharts
Moreover, Starbucks' dividend yield is currently at 2%. This is at the high end of its range since the company started paying a dividend over a decade ago. And when it comes to using the dividend yield as a valuation proxy, a higher percentage indicates cheaper.
For these reasons, I'd say Starbucks stock looks reasonably valued right now. But this reasonable valuation is based on severely depressed financial results in China. When China rebounds -- and it's reasonable to assume it will, eventually -- then Starbucks' revenue and earnings should soar, making the stock look very cheap after that happens.
Same-store sales for Starbucks in China fell an eye-popping 42% year over year in December. In short, the outlook for the first half of 2023 is already gloomy. Management is hoping business in China will pick up in the back half of the year. But that's far from certain.
Therefore, Starbucks' China catalyst may take time to materialize. But I believe shareholders will enjoy the benefits of a rebound in China with enough patience.
